Can anyone please show how to solve these? Corporate Finance (related to cost of
ID: 2806591 • Letter: C
Question
Can anyone please show how to solve these? Corporate Finance (related to cost of capital and beta, DCF valuation)
The following information pertains to questions 32 to 35.
Energy Corp. has a market capitalization of $15 billion and debt with market value of $5 billion. Energy will keep its current Debt-to-Equity ratio constant. The equity cost of capital is rE = 10% and the cost of debt is rD = 6%. The corporate tax rate is 35%. Assume a market risk premium of 6% and a risky-free rate of 5%.
The firm is considering an expansion project (i.e., same risk as the firm’s assets) with the following cash flows:
Year 0 1 2
Free Cash Flows ($M) -100 70 120
32. What is the Net Present Value of the project? (A) $ 65.00M (B) $ 66.51M X Correct (C) $ 70.00M (D) $ 72.24M
33. Assume (correctly or incorrectly) that the Net Present Value of the project is $65M. How much new equity will Energy need to start the project? (A) $ 75.00M (B) $ 58.75M X Correct (C) $ 50.50M (D) $ 45.00M
34. Energy’s debt Beta is closest to: (A) 0.15 (B) 0.17 X Correct (C) 0.20 (D) 0.23
35. Assume that the project is not an expansion project within Energy’s line of business (i.e., different risk). BigKup, a public firm, is believed to meet the requirements for a comparable firm. BigKup has an equity Beta of 1.5 and a debt-to-equity ratio of 1. BigKup can borrow at the risk free rate. What should the project’s discount rate be if the project were financed with equity only? (A) 9.5% X Correct (B) 10.5% (C) 11.0% (D) 14.0%
Explanation / Answer
first find wacc
wacc=(wt of debt*after tax cost of debt)+(wt of equity*cost of equity)
wt of debt=5/(5+15)=25%
wt of equity=75%
after tax cost of debt=6%*(1-35%)=3.9%
cost of equity=10%
WACC=(25%*3.9%)+(75%*10%)=8.475%
NPV= present value of future cash flows
32) NPV=-100+(70/(1+8.475%)^1)+(120/(1+8.475%)^2)
=66.51mn